Published in Business Spectator (Melbourne), 23 August 2012
After three years of the euro crisis, and despite numerous summits, various acronymed bailouts, and countless solemn pledges to save Europe’s common currency, we are nowhere closer to a solution than at the outset. The euro’s troubles have every chance of joining poverty in Sub-Saharan Africa, violence in the Middle East and North Korea’s nuclear program as a standard feature of the world in which we live: unpleasant, dangerous and yet seemingly unalterable.
How refreshing, then, that there are still novel ideas on how to tackle the European crisis, even if they are wacky. Last weekend, a group of prominent economists presented their miracle cure for the ailing euro currency: devaluation. Unfortunately, while it will have an effect of sorts, the proposed therapy will not end the euro crisis. In fact, it would only make it worse.
German Sunday paper Welt am Sonntag quoted Oxford economics professor Clemens Fuest, Dutch economist Paul de Grauwe and Berenberg Bank’s chief economist Holger Schmieding calling for a substantial euro devaluation against other major global currencies. In this way, say the three economists, struggling periphery economies could regain their competitiveness. Economic reforms alone, they argue, will not do the trick for countries like Italy and Spain.
Regular readers of this column know that I have often made similar points. It is all too obvious that economic reforms and austerity alone have not worked for Greece, Portugal or Spain. The combination of low productivity and high unit labour costs, particularly compared to the stronger euro core countries, have prevented an export-led recovery and a recalibration of trade and payments balances. For this reason, devaluation is precisely what Europe’s periphery economies need in conjunction with spending restraint and reforms.
So why then do I believe that Fuest, de Grauwe and Schmieding are dead wrong? Because, fundamentally, there is a massive difference between singling out crisis countries for a devaluation of their own currencies (after they have left the eurozone, that is) and an across the board devaluation for all members of the eurozone. It is mind-boggling how such excellent economists can overlook this important and yet basic detail.
The first problem with a euro devaluation is that it would not necessarily help the eurozone as a whole. To understand why, consider the structure of the eurozone’s imports. Last year, fuels accounted for 28.9 per cent of the EU’s imports. The eurozone is energy poor and heavily dependent on oil and gas imports. Increased energy costs from devaluation would thus offset some of the competitiveness gains, particularly for the manufacturing sector.
The second problem with euro-wide devaluation is even more severe. The difficulties faced by the euro are not linked to its external value. It is the internal differences between euro members that are causing the greatest trouble. Devaluation, however, would only affect the eurozone’s trade links with the rest of the world while leaving the cost differentials between, say, Germany and Greece unchanged. But the eurozone’s aggregate trade relationship with the rest of the world is emphatically not the issue.
According to the latest data from the EU’s statistical office Eurostat, the 17 members of the eurozone are recording a rising trade surplus with the rest of the world. The seasonally adjusted trade surplus grew from €2 billion in February to €10.5 billion in June. Judging by these figures, it is hard to justify claims that the eurozone as a whole has a competitiveness issue. If anything, it is too competitive.
The eurozone’s problems are not in aggregate but at the level of its individual members. On closer inspection it quickly becomes clear that the eurozone’s strong export performance is almost entirely due to a single member, Germany. As economic research institute Ifo estimates, Germany’s trade surplus this year will be $US210 billion – even larger than China’s $US203 billion surplus. Germany runs trade surpluses with both the other eurozone members and with the rest of the world.
A euro devaluation would only increase the power behind the German export steamroller. Currently, only 38 per cent of German exports go to other eurozone countries. The devaluation would not affect this intra-eurozone trade but it would blow up Germany’s massive trade surplus with the rest of the world even further. Is this what the three pro-devaluation economists have in mind? Probably not, since such trade imbalances are now thought to be one of the main drivers of global financial instability. If anything, Germany needs a stronger currency, not a weaker one.
For other eurozone countries, the situation is different. More than half of Spain’s exports, for example, go to other eurozone countries and about two thirds to other EU members. A euro devaluation would thus have a smaller effect on the Spanish economy, although it could at least cut Spain’s large trade deficit with the rest of the world.
What the euro devaluation would not do, however, is correct Spain’s weakness compared to Germany. It would not make Spanish companies more competitive relative to their German business rivals. It would not increase productivity, nor would it reduce relative labour costs within the eurozone. But this is the one aspect of Spain’s external economic relations that needs fixing most urgently.
To be clear, devaluation would make a lot of sense for Europe’s troubled periphery. But in order to work, these countries would need to devalue on their own, not together with Germany and the more productive euro core. So either Germany departs from the eurozone and allows a new deutschmark to appreciate, or the crisis countries return to peseta, lira and drachma and let devalue against US dollar, Stirling and of course the euro itself.
As much as I understand the esteemed economists’ desire to end the euro crisis quickly, even with bizarre proposals such as euro devaluation, not every medicine is effective and not every cure is better than the disease.
Chances are the euro crisis will remain with us for quite a few more years. Think of North Korea’s nuclear program.